Challenges in Designing Competitive Tax Systems

Remarks by Angel Gurría, OECD Secretary-General

OECD Conference Centre, 30th June 2011

(As prepared for delivery)

Ladies and gentlemen,
We are celebrating the OECD’s 50th anniversary during the tail-end of the worst financial and economic crisis of our lifetimes. Thus, it is a good moment to take stock and to ask some questions on where we are going with tax reform.

Many countries are facing difficult choices in their public finances. Deficits in the OECD area are running at around 7% of GDP, and the average debt to GDP ratio is approaching 100%. Few politicians contest the need to take action, but views differ on the speed at which budgets should be consolidated and on the balance between expenditure cuts and tax increases.

Tax increases will almost certainly have to be part of the consolidation package in most countries. The question is how to raise them without jeopardising the competitiveness of our economies and longer-term growth potential. Sustainable growth means delivering growth friendly fiscal consolidation.

How can we then raise additional revenues without harming entrepreneurship, innovation, or savings? And how can we do it without damaging the prospects of a job-rich recovery and the attractiveness of a country as a location for investment, particularly in the knowledge based sector?

There is no simple recipe, but the slogan long-associated with the OECD of following a broad base-low rate approach to taxation captures many of the essentials.

And yet there are limits to this approach. Tax policy is not just about producing a competitive tax environment. It’s also about producing a fair tax environment; one that takes account of the ability to pay, encourages high rates of compliance and operates with low administrative and compliance costs. It means assessing how far we should use the tax system to promote worthy activities like encouraging the consumption of merit goods or subsidise certain types of investment.

Many countries have endorsed and implemented the OECD recommendations to achieve this ideal of low rate, broad base taxes. Over the last 25 years, we have seen a largely unsung tax revolution. 25 years ago, many OECD countries had top marginal personal income tax rates of 70% plus. Corporate income taxes were often around the 45% mark. Today, it is rare to find a country with a top personal income tax rate over 50% or a corporate income tax of more than 35%. These cuts have not led – or at least not yet - to lower revenues from these taxes. At the same time, countries have begun the process of shifting towards higher reliance on VAT, primarily by increasing the standard rate of VAT and closing loopholes.

Many countries have also reviewed their international tax arrangements, with some moving towards a more territorial approach as regards corporate income tax. There has also been a concerted effort to extend the network of bilateral tax treaties based on the OECD Model and to achieve a more consistent application of the OECD Transfer Pricing Guidelines. Many revenue bodies are following the guidance provided by our Forum on Tax Administration. This Forum, which brings together 43 countries, promotes the idea that revenue bodies should be responsive to the needs of business for certainty, predictability and consistency.

And, of course, we have had the successful clampdown on tax havens and bank secrecy, which is already having a major impact on tax compliance.

But these are not the only ways in which governments have responded to these competitive pressures
Recently we have seen an increasing number of countries put in place preferential tax regimes for intangibles and for highly mobile individuals. We continue to see a proliferation of investment tax incentives, especially in non OECD countries, despite the ambiguous evidence on the effectiveness of such incentives for both domestic and foreign investment.

In this context, it is worth asking where this race to become more competitive will lead us to. How many of you have recently stated publically that you want your tax system to be the most competitive in the EU and the G20? Will this lead to a race to the bottom? Will we see the tax burden shift from mobile to immobile factors of production?

The underlying question is whether we need new rules on what are acceptable or unacceptable forms of tax competition.

In 1998, the OECD issued a report entitled ‘Harmful tax competition’. Roughly at the same time, the EU launched its Code of Conduct Group. The Southern African Development Community (SADC) is also exploring the idea of a code and just two years ago Mexico proposed a similar idea for the Latin America region. What these initiatives acknowledge is that governments lose, both individually and collectively, if they embrace this kind of competition. This suggests that if we want to maintain sovereignty in the design of our tax systems then we need better international co-operation.

The 1998 OECD initiative and the EU code went some way to achieving this. But I believe we need a new push to improve international tax co-operation that recognises that when governments act together, they are stronger.

This could include some of the following elements:

We need better analytical tools to measure and define more precisely what we mean by the competiveness of our tax systems. We need to move beyond measuring the business environment or relying only on the type of private sector comparisons that look at the Total Tax Contribution of enterprises. The OECD is working with our colleagues from the BRIICs and other emerging economies and stands ready to do this. We have the tools but we need your broader political support.

The granting of investment tax incentives should be done in open fashion and governments should regularly publish tax expenditure estimates of the cost of such incentives and to evaluate whether they are achieving their stated goals.

There is still much to be done to reduce compliance costs. High compliance costs can be just as much a barrier as high tax rates. And complexity only benefits one group: tax advisers. We stand ready to work with countries on how to reduce such costs.

As our economies integrate more and more we also need to increasingly consider how our tax systems link up both to avoid disincentives for cross-border trade and investment but also to limit the scope for gaming the system with multiple deductions, the creation of untaxed income and other unintended consequences of international tax arbitrage.

We also need to ask whether our current international tax arrangements are adapted to today’s global economic environment and the emergence of new players in the international economy. And also whether they are suitable for an environment where multinational enterprises dominate cross-border trade and where intangibles are the main generators of wealth. In a world where any particular taxpayer’s activities are likely to span multiple countries, governments need to acknowledge that an increasingly important aspect of their tax system competitiveness is how it interacts with the tax systems of the other jurisdictions.

We need to put in place adequate rules to ensure that double or multiple taxation will not result from operating in different countries And that opportunities are seized to harmonize compliance requirements rather than each country imposing its own requirements.

We must have a firm commitment to the goal of ensuring that internationally agreed principles are actually being applied, and are capable of being applied. It is also critical that we put in place effective international dispute resolution mechanisms to handle the inevitable frictions that will arise from the interaction of national tax systems.

In a nutshell: we need to move away from bilateral to multilateral instruments. And in order to meet these challenges we must put in place a process that is inclusive and takes into account the views of all key players, not just OECD countries.

Ladies and gentlemen,
Governments need to continually evaluate the economic and social impact of their tax structures. As the global environment changes, we need to adapt our governance structures. Here the OECD can help by developing a common analytical framework to assess the cost of incentives. This methodology would evaluate the overall impact of tax and expenditure systems on the distribution of income and wealth, thereby moving the debate away from looking at a particular tax to looking in a holistic way at the overall impact of the tax and expenditure systems. We began some of this work in our recent publication “Growing Unequal”, but more needs to be done.

No country or even regional grouping of countries can provide the solution to all of these issues. But I do hope that this meeting will represent the beginning of a global dialogue that will help us build a stronger, cleaner, fairer and more effective tax environment.
Thank you